8 Types of Personal Loans And How They Work

Personal loans may be seen as a last resort for covering large expenses or consolidating debt, but they can actually be a helpful financial tool.

They offer lower interest rates than credit cards and often don’t require collateral, making them a safer and more affordable option for financing.  

There are many kinds of personal loans, however, and picking the right one for your needs is critical.

A personal loan is a type of installment loan that provides a lump sum of money upfront and is typically offered by banks, credit unions or online lenders like SoFi and Upgrade.  

Once the funds are disbursed, the borrower begins making regular monthly payments that include a portion of the principal plus interest.

Personal loans can be used for any variety of purposes, from paying medical bills and consolidating debt to financing a wedding or buying a new car. Platforms like LendingTree and Credible let you compare personal loan offers from multiple lenders without affecting your credit score.  

Not all loans are created equal, though. Some require collateral, while others are unsecured. Some have fixed interest rates, while others are variable.

Understanding the differences can help you choose the one that best fits your financial needs and protects you from unexpected risks.  

An unsecured loan doesn’t require collateral, which means you won’t risk losing an asset, like your car or house, if you default. Student loans, medical loans and debt consolidation loans are all types of unsecured personal loans.

Lenders look at your credit, income and financial history to decide whether to approve you for an unsecured loan. The higher your credit score, the better your chances are of being approved for the best rates.

They may also review your employment history and education, especially if your credit history is thin.

LightStream offers low-interest unsecured personal loans with flexible terms for people with good to excellent credit.

An unsecured loan isn’t without risks. Defaulting on payments can seriously hurt your credit score for years. Your lender may tack on late fees and refer your debt to a collection agency, and they can also sue you to recover the balance. If they win, your wages can be garnished or a court order may allow them to withdraw funds directly from your bank account.

Who’s this for? An unsecured loan is best for borrowers with good credit who want to finance a large expense, like a wedding or home repairs, without risking assets.  

A secured loan, on the other hand, is backed by collateral. That means if you fail to make payments, you agree to hand over an asset, like your car or house. Because there’s less risk to the lender, secured loans often come with lower interest rates and easier approval requirements.  

OneMain Financial Personal Loans approves applicants with bad or fair credit by securing their loans with collateral.

Who’s this for? Secured loans are best if you have a low credit score or want a better rate and are comfortable putting something valuable on the line.  

Fintech company SoFi lets you choose between a fixed or variable rate.

With a co-signed loan, a second party (often a parent, spouse or friend) applies for the loan, as well, in most cases because the primary applicant has bad credit or a thin credit file. More than 90% of private student loans are co-signed, for example.

A co-signer can greatly improve your chances of getting approved or receiving a better rate. The co-signer does not have access to the loan funds but legally shares responsibility for the debt and is responsible for repayment if the primary borrower falls behind or defaults.

With student loans, lenders often allow co-signers to be released from their obligation after a certain number of on-time payments. Education lender Edly only requires borrowers to make six consecutive monthly payments before allowing a co-signer to be released, the shortest term we’ve found.

Prosper allows borrowers to submit a joint application and issues loans from $2,000 up to $50,000, with repayment terms of up to 60 months.

A debt consolidation loan combines multiple debts — like credit cards, medical bills and payday loans — into one single monthly payment. Not only are you able to get a lower interest rate, but you only have one payment to keep track of.  

Keep in mind that consolidating doesn’t eliminate your debt. It just restructures it.  

Upgrade offers debt consolidation loans for up to $50,000, making it a solid choice if you have large debts. Funds can be available the next business day or you can choose to have Upgrade send payment directly to your creditors.

Who’s this for? Debt consolidation loans are best if you have multiple high-interest debts, like credit card bills, and want a lower rate and a more simplified payment structure.

A personal line of credit is a flexible loan that works like a credit card and is best suited for borrowers who need access to cash over time, rather than in a lump sum. 

You’re approved for a certain credit limit and can draw from it as needed, paying interest only on the amount you use. It’s a revolving form of credit, meaning you can reuse the funds as you repay them.

Personal lines of credit often require strong credit and steady income. U.S. Bank approves applicants with a 680 FICO Score for lines of credit up to $25,000, with no application fee or annual fee.

A buy now, pay later (BNPL) loan is short-term financing usually offered at checkout that lets you split your payment into smaller installments, often with no interest if paid on time. 

BNPL can be helpful for financing small-to-midsize purchases, but it can also lead to overspending. Missing a payment could also trigger fees and hurt your credit score. 

Klarna and Afterpay are among the leaders in the BNPL space, accepted by thousands of stores.

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